When you own stock in a company, you hold an ownership stake that allows you to potentially profit as the company performs well. Two main types of stock – preferred and common stock – each have different advantages and disadvantages, including voting rights and priority in claiming dividends and assets.
Companies issue both preferred or common stock to raise money for any number of reasons, such as to pay off debt, launch new products, expand into other markets, or build new facilities. Learn more about the differences between preferred versus common stock and how to choose which type of stock may be best for your portfolio.1
What Is Preferred Stock?
The definition of preferred stock is an ownership stake in a company that gives the shareholder preferential rights to dividends and assets. Preferred stockholders get “preferred” treatment in that they are paid dividends before common shareholders. They also have priority over common shareholders for company assets if the company is liquidated, such as during a bankruptcy. Although, a company’s bondholders have priority over preferred stockholders when a company distributes assets.
However, preferred stock tends to be more expensive per share and it usually does not include voting rights or only includes limited voting rights.2,3
How Preferred Stock Works
Companies often issue preferred stock to raise money without impacting the controlling interests of other stockholders. Generally, preferred stock tends to increase in value more modestly than common stock when prices rise, but its dividends are often larger.
Preferred stock has characteristics similar to bond features, such as a fixed rate of income. Preferred stock can also be callable, meaning the company can redeem it at a pre-determined price after a certain date but before its maturity date. A preferred stock’s callable features, if it has any, will be defined in its prospectus.
Dividends on preferred stocks are often cumulative, which means that if the company does not pay them at the expected date, it will pay them later. The company must pay all the accumulated dividends it owes to preferred stockholders before it pays common stockholders, so preferred stocks are considered less risky.
In some cases, preferred stock is convertible to common stock. The shareholder can typically choose whether to convert their shares, but in some cases the company has authority over whether and when they are converted. Companies may issue convertible stock to raise money quickly when they cannot secure more conventional funding sources.4
What Is Common Stock?
Common stock is an ownership stake in a company that includes voting rights for shareholders, who are also entitled to any dividends. With common stock, owners can vote on corporate policies, and they can participate in electing a board of directors. Usually, shareholders get one voter per share.5
However, if a company is liquidated such as with a bankruptcy, common shareholders will be repaid after creditors and preferred stockholders. And if a company eliminates its dividend, a common stockholder will not be paid. In contrast, preferred stockholders typically receive a missed dividend on a later date.6
How Common Stock Works
Common stock, like preferred stock, represents a portion of ownership in a company. It can be purchased over major exchanges like the New York Stock Exchange (NYSE) or NASDAQ. If a company cannot meet the listing requirements of a major exchange, it can trade over-the-counter (OTC), which is through a broker-dealer network instead of an exchange.
Stockholders can benefit from capital appreciation if the value of the stock increases, such as when the company performs well. (Although a stock’s value can also decline for other reasons like if a company is not managed well or loses revenue.) They can also benefit from dividends, or earnings that the company distributes, and from having voting rights, which allow them to participate in decisions about the company.
The Bottom Line
Preferred stock and common stock are both equity instruments that provide an ownership stake in a company, but they have different advantages and disadvantages. The type of stock that is right for your portfolio will depend on several factors, including whether you want to participate in voting on company issues or if you want to ensure you receive dividends before common shareholders.
Consider consulting with a financial advisor who can guide you through selecting the right assets for your portfolio. Factor in your financial situation, investing goals, and time horizon as you decide which type of stock fits your needs.
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1 Investor.gov, “What are stocks?” https://www.investor.gov/introduction-investing/investing-basics/investment-products/stocks
2 Cornell Law School Legal Information Institute, “Preferred Stock” https://www.law.cornell.edu/wex/preferred_stock
3 NY Attorney General, “Understanding Common Investments: Stock” https://ag.ny.gov/investor-protection/understanding-common-investments-stock
4 Investor.gov, “Convertible Securities” https://www.investor.gov/introduction-investing/investing-basics/glossary/convertible-securities
5 NY Attorney General, “Understanding Common Investments: Stock” https://ag.ny.gov/investor-protection/understanding-common-investments-stock
6 Investor.gov, “What kinds of stocks are there?” https://www.investor.gov/introduction-investing/investing-basics/investment-products/stocks#Kinds
